Exchange Rates: What They Are And How They Can Impact Your Business (2024)

Key Takeaways

The exchange rate is the price of one currency in terms of another. For example, if USD 1 = CAD 1.4, this means it costs 1 US dollar to buy 1.4 Canadian Dollars.

Exchange rates can lower import costs or increase export revenue if your home currency weakens, but it can also do the opposite if it strengthens.

Businesses can mitigate the risks of currency fluctuations through various strategies, which include currency hedging (locking in a future exchange rate).

As an international business, you may have ongoing international payments in different currencies flowing into your bank account or may need to pay suppliers in a currency different from your home currency.

Therefore, it is inevitable to understand how one of the most liquid financial markets works and eventually, gain profits through these value fluctuations.

This article will outline everything you need to know about exchange rates, including what they are, why they matter to your business, and how you can make them work for you.

Let’s dive right in.

What Is an Exchange Rate?

In essence, an exchange rate is the price of one currency in terms of another. It's like a price tag you see when you're swapping one item for another.

For example, if you're buying products from Chinese suppliers, the price might be listed in Yuan. The exchange rate will help you figure out how much it will cost in your home currency.

Countries don’t necessarily always use their own official currencies.

Sometimes, countries with smaller economies adopt a currency from a larger, more stable economy. This is often done to combat inflation, promote economic stability, and facilitate trade.

Take Ecuador as an example. Instead of using their country’s currency, they prefer to use the U.S. dollar to address hyperinflation and stabilize their economy.

Similarly, France, Germany, Italy, and other European countries adopted the Euro as a common currency to promote economic integration and facilitate trade within the Eurozone.

Why Do Exchange Rates Matter to Your Business?

Exchange rates have a negative impact on your profitability and competitiveness. When the rate fluctuates, they can:

  • Impact your costs: If you import goods, a stronger local currency can mean lower costs, while a weaker one can make imports more expensive.
  • Affect your revenue: If you sell overseas, a weaker local currency can boost your revenue as your products become cheaper for foreign buyers.
  • Change the value of your investments: If you have investments in foreign currencies, exchange rate changes can affect their value in your local currency.

Thus, it is crucial to manage your exposure to these fluctuations to maintain your financial health and remain competitive in the global marketplace.

Exchange Rates: What They Are And How They Can Impact Your Business (1)

Exchange Rates: What They Are And How They Can Impact Your Business (2)

Recommend: Learn how forex trading can minimize foreign exchange rate risk.

How Exchange Rate Works

Exchange rates represent the relative value between different currencies, constantly fluctuating due to various economic and political factors, including interest rates, inflation, and government policies.

Currency Pairs and Quotes

Exchange rates are often expressed as currency pairs, such as USD/GBP. Each pair has two basic parts:

  • Base currency: The currency you are using to purchase another currency (in this example, USD).
  • Quote currency: The currency you want to buy (in this example, GBP).

The exchange rate tells you how much of the base currency (USD) is needed to buy one unit of the quoted currency (GBP). Suppose the exchange rate between USD and GBP is 2. It costs GBP 2 to buy USD 1.

Direct and Indirect Quotes

There are two methods for quoting the currency - either through direct (in American terms); or indirect (in European terms).

  • Direct quote (American terms): This shows the price of one unit of foreign currency in terms of the domestic currency. For example, USD 1.20/EUR means it costs 1.20 US dollars to buy 1 Euro.
  • Indirect quote (European terms): This shows the price of one unit of domestic currency in terms of foreign currency. For example, JPY 110/USD means you get 110 Japanese yen for 1 US dollar.

Exchange Rates: What They Are And How They Can Impact Your Business (3)

Exchange Rates: What They Are And How They Can Impact Your Business (4)

Did you know? Most currencies are quoted against the US dollar because it's the global primary reserve currency, held in large quantities by reserve banks and used in countless international transactions.

Types of Foreign Exchange Rates

Now that you know how exchange rates work, here are 3 types of currency exchange rates that you should know about.

Fixed Exchange Rates

A fixed exchange rate is a system where a currency's value is held relatively constant against another currency or a group of currencies. This stability is achieved by central banks actively managing the exchange rate.

For businesses, fixed rates offer predictability. This makes it easier to plan international transactions and forecast costs.

However, there's a trade-off, as it limits a country's ability to independently control its own monetary policy.

Please note that the fixed exchange rates are not truly fixed. They are allowed to fluctuate within a small range.

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Exchange Rates: What They Are And How They Can Impact Your Business (6)

Example: Notable examples include the Hong Kong dollar, which is pegged to the US dollar, and the Danish krone, which is tied to the euro.

Floating Exchange Rates

Floating (or flexible) exchange rates are the opposite. Their value is determined by supply and demand in the FX market, which means it constantly shifts based on forex trading activities.

The floating exchange rate is more commonly used by countries nowadays.

The flexibility allows countries to adjust to changing economic conditions, but it also means more volatility and uncertainty.

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Exchange Rates: What They Are And How They Can Impact Your Business (8)

Example: Most major currencies, including the US dollar, euro, Japanese yen, and British pound, are floating.

Managed Floats Exchange Rates

A managed float, sometimes called a “dirty float”, is a hybrid approach that combines elements of both fixed and floating regimes.

Instead of a single fixed point, the central banks set a target range for their currency's value and intervene in the market to keep it within those bounds. This provides some stability while still allowing for flexibility to respond to changing economic conditions.

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Exchange Rates: What They Are And How They Can Impact Your Business (10)

Example: The Chinese yuan. The People's Bank of China sets a daily reference rate for the yuan against the US dollar and allows limited fluctuations around that rate (typically around 2%).

How to Manage Currency Exchange for Your Business

Dealing with multiple currencies doesn't have to be a headache. Here are some strategies to manage exchange rates effectively:

Currency Conversion

If your company involves exporting and importing goods from some other overseas countries, chances are you would probably need to pay your trading partners in their nation’s currency or you can receive payments from your customers in another currency.

One quick and simple way is to ask your bank to help you convert the currency into their local capital payments at a spot rate.

But then the problem is traditional banks will charge a lot of different fees which can add up the cost for you.

Alternatively, fintech firms such as neobanks and payment service providers often provide competitive exchange rates and charge lower conversion fees. This can help you and your business save money and improve the bottom line.

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Exchange Rates: What They Are And How They Can Impact Your Business (12)

Interested? Check out our list of the top 19 neobanks in the market.

Currency Hedging

One of the biggest concerns for businesses dealing with foreign currencies is that the exchange rates increase or decrease larger than you anticipated.

Let's face it: it can eat into your profits.

Currency hedging is a risk management strategy that can help safeguard your business from unfavorable movements.

Some companies use hedging as a safety net in case of a time gap from payment to receiving the bill from customers.

In other cases, if you have to pay an overseas vendor, you wouldn’t want to have too much swing in exchange rate just so you don’t need to pay extra because of increased exchange rates.

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Exchange Rates: What They Are And How They Can Impact Your Business (14)

Tip: Learn how forward contracts can hedge against exchange rates.

Currency Arbitrage

Currency arbitrage is a more complex strategy that takes advantage of small price differences for the same currency in different markets.

For instance, if the euro is priced lower in Hong Kong than in London, a trader could potentially buy euros in Hong Kong and sell them in London, profiting from the price difference.

While it can potentially generate quick profits, arbitrage comes with substantial risks. Success requires expertise, specialized tools, and a deep understanding of market dynamics.

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Exchange Rates: What They Are And How They Can Impact Your Business (16)

Important: Due to the complexity and risks, businesses interested in arbitrage should consult with financial professionals experienced in this specialized area.

Final Note

We hope this guide has given you a better understanding of exchange rates and how they can impact your business. If you're looking for a reliable partner in Asia to help you manage currency exchange, discover how Statrys can simplify your cross-border transactions with competitive exchange rates and nominal markup. Our tailored solutions can help your business save money, reduce risk, and unlock new opportunities in international trade.

Exchange Rates: What They Are And How They Can Impact Your Business (2024)

FAQs

Exchange Rates: What They Are And How They Can Impact Your Business? ›

Changes in exchange rates affect businesses by increasing or decreasing the cost of supplies and finished products that are purchased from another country. It changes, for better or worse, the demand abroad for their exports and the domestic demand for imports.

How do exchange rates affect your business? ›

For entrepreneurs, changes in exchange rates affect their businesses in two main ways: by changing the cost of supplies that are purchased from a different country, and by changing the attractiveness of their products to overseas customers.

What does an exchange rate tell you in business? ›

The exchange rate is the price of one currency in terms of another. For example, if USD 1 = CAD 1.4, this means it costs 1 US dollar to buy 1.4 Canadian Dollars. Exchange rates can lower import costs or increase export revenue if your home currency weakens, but it can also do the opposite if it strengthens.

What are the effects of the exchange rate? ›

1. In the goods market, a positive shock to the exchange rate of the domestic currency (an unexpected appreciation) will make exports more expensive and imports less expensive. As a result, the competition from foreign markets will decrease the demand for domestic products, decreasing domestic output and price.

What are exchange rates in business example? ›

The impact of exchange rates

If the value of the pound increases, more foreign currency can be purchased for the same number of pounds. For example, if the value of the pound changes from £1 = US $1.20 to £1 = US $1.25 then £100 would now convert to US $125 instead of US $120.

What are the advantages of exchange rate in business? ›

Trade Confidence: Businesses can plan for transactions without worrying about sudden currency value changes, making cross-border trade more predictable and manageable. Reduced Exchange Rate Risk: Fixed exchange rates eliminate the currency risk associated with fluctuating exchange rates.

What is the exchange rate risk in business? ›

Exchange rate risk refers to the risk that a company's operations and profitability may be affected by changes in the exchange rates between currencies. Companies are exposed to three types of risk caused by currency volatility: transaction exposure, translation exposure, and economic or operating exposure.

What is the importance of exchange rates? ›

Aside from factors such as interest rates and inflation, the currency exchange rate is one of the most important determinants of a country's economic health. A higher-valued currency makes a country's imports less expensive at home and its exports more expensive in foreign markets.

What is exchange value in business? ›

“Value exchange” is a term rooted deeply in business fundamentals; it literally means that a consumer should receive some value for the service or product they are purchasing from you, but it also has interesting applications in the world of teamwork and collaboration.

What is an example of an exchange rate? ›

For example, an AUD/USD exchange rate of 0.75 means that you will get US75 cents for every AUD1 that is converted to US dollars.

Do exchange rates affect the prices of goods? ›

When the value of a currency changes, prices for goods traded using that currency can be affected. A currency appreciation (when the value increases over time) results in a lower effective price for imported goods; currency depreciation (when the value decreases over time) translates to higher import prices.

How does the exchange rate affect economic growth? ›

By raising the domestic currency price of foreign exchange devaluation increases the price of traded goods relative to non- trade ones. This causes a reallocation of resources resulting in increased production in import competing sectors.

What is the strongest currency in the world? ›

1. Kuwaiti dinar. Known as the strongest currency in the world, the Kuwaiti dinar or KWD was introduced in 1960 and was initially equivalent to one pound sterling. Kuwait is a small country that is nestled between Iraq and Saudi Arabia whose wealth has been driven largely by its large global exports of oil.

What is exchange in business example? ›

Real-world Examples of Business Exchanges

For example, when you visit a local bakery to buy a loaf of bread, what's happening is an exchange. You're providing money to the baker, and in return, you're receiving the bread that you require.

Is a higher or lower exchange rate better? ›

A higher exchange rate is better if you're buying or sending currency, as it means you get more currency for your money. A lower rate is better if you're selling the currency. This way, you can profit from the lower exchange rate.

What will happen if the exchange rate fluctuates? ›

When exchange rates change, the prices of imported goods will change in value, including domestic products that rely on imported parts and raw materials. Exchange rates also impact investment performance, interest rates, and inflation—and can even extend to influence the job market and real estate sector.

What are the disadvantages of exchange rates for business? ›

Currencies can experience rapid and unpredictable fluctuations, which can introduce uncertainty for businesses engaged in international trade and investment. Currency Risk: The volatility of exchange rates introduces currency risk for businesses and investors.

How do interest rates affect a business? ›

In an environment with high interest rates, businesses may have to balance rising fixed costs like labour or supplies whilst remaining competitive in a market where customers have less overall money to spend and so become more cost conscious.

How does a weak pound affect businesses? ›

On the flipside, a weak pound can be damaging for companies that import goods from abroad and for those with supply chains around the world. A weaker pound can also push inflation higher as the UK imports more than it exports, meaning that the cost of producing goods gets more expensive.

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